Rubin's follow up

Well, well! A day after I post my views on the US fiscal situation citing Robert Rubin's 2003 book, the man himself comes out with an Op-ed on the same subject in NYT.  And we both think the issue needs to be addressed by President BO decisively in his 2nd term.  Here is the complete op-ed.

November 12, 2012

The Fiscal Delusion

By ROBERT E. RUBIN

NOW that the election is over, Washington’s attention is consumed by the looming combination of automatic spending cuts and tax increases known as “the fiscal cliff.” That combination poses risks, including economic contraction and erosion of confidence in government. But it also offers a chance to address our unsustainable and dangerous fiscal trajectory.

Much of the current energy around establishing sound fiscal conditions is focused on plans that theoretically would both contribute revenue to deficit reduction and significantly reduce individual income tax rates. Though hugely appealing, that’s a tall order.

These plans rely on reducing or eliminating many tax deductions, exclusions and the like, known collectively as tax expenditures. Reducing tax expenditures to pay for both lower personal income tax rates and deficit reduction may seem like a politically attractive alternative to raising tax rates or cutting entitlements or other spending.

However, many of these tax expenditures are important and popular policy programs on which people now rely. They include the deductibility of mortgage interest, charitable contributions and the exclusion from income of employer-provided health insurance. Some tax expenditures should be cut back and reformed. But when the substantive effects and political realities of large-scale reductions are examined, it becomes clear that there would not be sufficient savings to reduce tax rates and also cut the deficit.

Not long ago, a former senior official involved in the federal budget process told me that various senators used to meet with him periodically and argue for reducing tax expenditures. He would say that was a good idea, and then go down the list of large tax expenditures. At each one, the senator would say, “Oh no, we can’t do that,” and at some point the senator would repeat his proposition and the conversation would end.

The nonpartisan Congressional Research Service examined the full range of existing tax expenditures and concluded that, “Given the barriers to eliminating or reducing most tax expenditures, it may prove difficult to gain more than $100 billion to $150 billion” a year. But most plans based on reducing tax deductions and other expenditures project revenues of three to four times that amount. And the 1986 Tax Reform Act, cited as an example of lowering rates through tax expenditure reductions (called base broadening), left all of the major individual tax expenditures largely unchanged.

The plans that reduce both tax rates and deficits, like the impressive work by the Simpson-Bowles commission, have served a great public service — raising awareness of our fiscal risks, bringing Democrats and Republicans together, providing a framework aimed at stabilizing debt at an acceptable level, and recognizing the need for substantial revenue increases and spending cuts.

However, these same plans also pose a serious risk to achieving the very objective they seek. If we invest too much time and effort pursuing plans that ultimately prove undesirable and unworkable, we may go down a road that leads nowhere. Then we would be forced to search for a new solution when it will almost surely be too late. In effect, we will have pursued the policy equivalent of a wild-goose chase only to discover that, to mix metaphors, the tax expenditure goose doesn’t have enough golden eggs.

Advocates of extensive tax expenditure reduction argue — correctly — that all deficit reduction choices involve substantive costs and are politically difficult. They then suggest that, when compared to other possibilities, substantially more cuts may be doable than the Congressional research numbers suggest.

Maybe, but I think that’s unlikely when compared to the alternative of restoring the topmost tax brackets to their Clinton-era level.

Raising tax rates for those with the highest incomes challenges the supply-side proposition that even moderately higher rates would hurt growth. President Bill Clinton’s 1993 deficit reduction plan increased income tax rates for roughly the top 1.2 percent of incomes. Opponents said this would lead to recession. Instead, we had enormous job creation and the longest economic expansion in our history.

A recent report by the Hamilton Project, an economic policy project on whose advisory council I serve, reviewed 23 studies of the impact of tax-rate changes on the propensity to work and found that most of them concluded there was no meaningful effect. Tax expenditure reductions, on the other hand, will not raise nearly the revenues needed for sufficient deficit reduction without increasing taxes on the middle class significantly and are likely to disrupt important social and economic goals, though many economists don’t acknowledge that.

When you compare raising the marginal rates for roughly 2 million Americans to phasing out health insurance exclusions that would affect 150 million Americans — even if some reform should be done — I don’t think it’s a close call substantively or politically.

We should let the Bush high-end tax cuts expire, with an achievable, progressive reduction in tax expenditures. And we should have spending cuts, including entitlement reforms, equally matched by revenue increases. The entire program — including budgetary room for public investment and a moderate upfront jobs package — could be enacted now and deferred for a limited time with a serious mechanism to guarantee implementation.

For plans that both reduce deficits and lower rates, some suggest that, instead of raising the top two brackets to Clinton-era levels, we can find the same revenues by limiting tax expenditures for those groups. That would have some meaningful negative policy impacts, unlike increasing the top rate. The bigger problem is that such a step would yield only a fraction of the necessary revenue, requiring higher taxes on the middle class.

The pressure of the fiscal cliff, the fact that doing nothing is not viable, and the distance to the next election all combine to make this a special opportunity to meet our fiscal imperative. We need an open, cleareyed debate so we don’t squander it. 

Robert E. Rubin was Treasury secretary from 1995 to 1999 and is a co-chairman of the Council on Foreign Relations.

Rubin's In an Uncertain World

               Just finished reading “In an Uncertain World” by former US Treasury Secretary and later Citigroup Chairman, Robert Rubin.  After the 2008 Crisis burst on the international scene, alongwith former Fed Chairman Alan Greenspan Rubin had come in for criticism that he had helped engineer the repeal of the Glass Steagall Act which allowed commercial banks to undertake investment banking business.

This book however was published much before (2003) the GFC 2008 and essentially is an account of Rubin’s time in Goldman Sachs and later as Treasury Secretary in Clinton Administration from 1995 till 1999. It was certainly an eventful period in the annals of modern finance and would be remembered for a chain of economic crises which started in Mexico, followed by East Asia, then Argentina and finally the Russian default which also led to the failure of the LTCM hedge fund in the US.

Rubin provides details of how the Clinton Administration dealt with each one of these crises and more often than not the global economy came out more bruised than before from each one of them.  Given that Obama got re-elected as President just last week, I will discuss and record two themes here from the book.

1.       The Uncertain World: Rubin analyses his ideas about uncertainty and how he understood it and coped with it in life.  Following are his “principles” as framed by him:

                                 i.            The only certainity in life is that nothing is ever certain.

                               ii.            Markets are good, but they are not the solution to all problems.

                              iii.            The credibility and the quality of a nation’ policies matter for its prospects than anything United States, the G-7, or the international financial institutions can do.

                             iv.            Money is no substitute for strong policy, but there are times when it is more costly to provide too little money than too provide too much.

                               v.            Borrowers must bear the consequences of the debts they incur – and creditors of the lending they provide.

                             vi.            The United States must be willing to be defined by what it is against, as well as what it is for.

                            vii.            The dollar is too important to be used as an instrument of trade policy.

                          viii.            Optionality is good in itself.

                             ix.            Never let your rhetoric commit you to something you cannot deliver.

                               x.            Gimmicks are no substitute for serious analysis and care in decision making.

 

I quite like the last idea.

2.       The other theme is the US fiscal deficit.  The deficit which had come in to existence after the dot com bust (the US actually had a fiscal surplus by the end of the Clinton presidency)  has continually ballooned and thanks to the Bush wars and the GFC US today is battling with the worst ever fiscal deficits in history.  After Obama’s re-election the debate rather the battle over deficit reduction is now out in the open.  Over the last decade, the Republicans have taken complete leave of their senses on this subject.  The Party of No, as they are now called, have applied all sorts of perverted logic in order to preserve the tax cuts for the rich while at the same time calling for cuts in the welfare programmes which largely benefit the poor.  Rubin has very cogently explained the Clinton Administration approach towards the reduction of deficits and once again it is up to a Democrat president to stand up to the combined idiocy of the Republicans who seem to have learnt no lessons despite overwhelming evidence that the Reagan’s supply side economics regarding (also known as Dynamic Scoring) tax cuts for the rich is not working.

Thus I feel that Obama has the weight of history behind him and in the coming months we may witness bloody battles with the GOP over deficit reductions.  As Obama has clearly been handed a clear victory by the Americans, Republicans would be fighting with their backs against the wall.  If Obama succeeds in getting his plans through, there would be an adverse impact on the risk markets. But as was shown in the recent fall in Dow and which did not translate in a similar fall in the Indian equities, I think this was a small trailer of the movie that I expect to play out between mid-December till mid-January but an Obama victory will over the next 4 months to 6 months would be clear boost for the risk markets.